Monday, July 11, 2005

So How Far Does This Google Thing Go?


I suppose you can make a case that Google is a low value-add search provider ready to get its clock cleaned when Microsoft wakes up and does whatever it wants to do to wipe Google off the map.

Personally, I’m not sure how Microsoft will ever get its act together, given an operating system under perpetual virus attack, and a founder who spends two weeks a year sitting by a lake in a cabin Thinking Big Thoughts About Technology (see "Bill's Hideaway" from March 28, 2005) while anonymous engineers in Mountain View are dreaming up slick and useful new technology like Google Maps.


Besides, as I have pointed out here before, Microsoft’s M.O. is to give away something—like a database or a spreadsheet or a web browser—along with its operating system in order to undercut the Borlands and Lotuses and Netscapes of the world. But, since Google doesn’t charge the user for search, Microsoft can’t undercut free.

Yahoo, meanwhile, appears to want to be the Warner Brothers of the web—owning and charging for content—which makes sense given its CEO’s previous gig at Warner Brothers.

I’d argue Google could eventually displace Microsoft as the most important, and profitable, technology-based company.


Before you spit out your coffee at that, consider this: it took Microsoft 15 years from inception to reach $1 billion in sales. It took Google 5. And it took Microsoft 18 years to reach $3 billion in sales; Google 8.

Unlike the early internet companies during the dot-com boom that generated fake sales via non-cash swapping of services, Google’s business is cash-based, quit
e real, and being taken from newspaper, radio and television advertising media of all stripes.

For example, in the first quarter of 2005, Google's revenues hit $1.256 billion, versus $249 million the same quarter of 2003. Meanwhile, at the New York Times, revenues in the like period jumped a non-whopping $21 million, from $784 million to $805 million.

For Dow Jones, the increase during the same period of time was a modest $54 million, including acquisitions.

The thing I admire most about Google is that everything the company does is intended to drive more traffic on its highway. That single-mindedness—which is perceived as a weakness by skeptics of Google’s business model—is, in my opinion, management’s best quality.

It reminds me of Wal-Mart, which has one mission in its corporate life: to get customers into the stores. And it leads me to believe Google will succeed in fending off perceived threats to its dominant position, whether from the Evil Empire in Redmond or the Yahooligans in Sunnyvale.

One group that poses no threat to Google are the Overstockians based in Salt Lake City, and tomorr
ow we will see how many of those steal-of-a-lifetime diamonds Patrick and the crew sold this quarter.



Jeff Matthews
I Am Not Making This Up



The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

21 comments:

rip said...

troll?

Its_strange said...

Could Google offer free online video games and have advertisers pay the bill ?

techblech said...

I agree that G has a single-minded focus in driving people to its store, but I argue that they'll have to seriously bulk-up their personnel in order to maintain and innovate current programs. Google Earth is cool and a technological tour-de-force, but their established money-makers, i.e. the trinity of Search/AdWords/AdSense are showing signs of becoming increasingly difficult to manage, and according to webmaster forums, skimpy regard to customer service is a big gripe.

dthorn said...

provacative, but... What is the stock worth?

Separately and to your point, GOOG would have to grow at 55% for five years to reach the 44b est. for MSFTs 06 Rev.

or 50% for five years to reach MSFTS est for 06 Net of 15b

A neat trick for a company whose 05 to 06 growth is estimated at 40% for Rev and 33% for Net. Thats right, they have pulled the exquisite management task of adding costs faster than revenues - or at least that is the expectation. Such strong management, I am sure, is part of the reason investors are so happy to pay steep multiples for the stock.

I know, you didnt limit the GOOGs dominance to being achieved in 5 years, however, do you really have confidence even 5 years out?
I'll wager 100 paypaldollars that in five years, whatever other technological changes take place, paid search will be considered a crude niche market in on-line advertising.

Sure GOOG will have its fair share, just not 44b worth. Come to think of it, another 100 says a dart picks a better performing stock than GOOG over the next five years more than 50% of the time.

Jeff Matthews said...

"dthorn" writes: "they have pulled the exquisite management task of adding costs faster than revenues..."

Actually, thus far, costs have risen slower than revenue.

But that will change as they ramp up qualified hires. Management wrote about this in their S1, they said it on every conference call, and they talked about it at their annual meeting--which is why margins decline next year.

If the revenues slow as much as forecast.

As for "its strange"'s question about Google offering online video games: they will do whatever it takes to drive search.

dthorn said...

http://online.wsj.com/article/0,,SB112112375764182774,00.html?mod=todays_us_marketplace

This article, WSJ B10 7/12/2005, makes my point about the infancy of web advertising. "In the early days of television, TV commercials were essentially ads written for the radio...It took advertisers time to realize the potential offered by the new medium."

"Online advertising has until now been dominated by search-related messages and banner ads. But that is changing, as the number of Web surfers using high-speed Internet services grows."

A major difference between MSFT and GOOG is that MSFT is/was a monopoly. While it is great that GOOG has to innovate to stay relevant - which MSFT never did/does, they can still only hope to capture a piece of internet traffic/advertising. Right now that is disproportionately large as they were the first to come up with a great on-line ad revenue business model. At the end of the day, though, they are not in a monopolistic position.

Oh, and what did you say the stock was worth again?

cdub said...

"it took Microsoft 15 years from inception to reach $1 billion in sales. It took Google 5. And it took Microsoft 18 years to reach $3 billion in sales; Google 8."

So part of your point is that it took MSFT and GOOG the same amount of time (3 yrs) to go from $1B to $3B in revenue? Which means that MSFT's growth was accelerating, or at least decelerating more slowly, than GOOG's, since it took MSFT much longer to get to $1B. The point...GOOG could find it much harder to continue the pace.

Jeff Matthews said...

Don't believe I ever discussed the stock price.

Don't believe I ever will. Stock price discussions are pointless, being subjective.

Good point about Microsoft-as-monopoly, and about the infancy of web-based advertising.

Gnanakan said...

Maybe you can undercut free? Assuming that Google is sharing AdWord revenue with other websites, any competitor such as YHOO or even MSFT who has a similar service could possibly offer websites a higher proportion of the click through revenue, right?

Just as e-mail has become free, there's not many barriers for all of Google's business with regards to price competition. There is currently no evidence supporting the notion that even those who regularly use google (myself included) will still be using it 5 years from now. Remember, there were many previous search companies ie alta vista, etc. that fell by the wayside. Why is GOOG 100% here to stay and dominate forever?

Just as print and other media are currently losing out to the internet, we must also realize that for people to have trusted news/information sources on the internet there has to be a system in place where people who fill that void get paid, meaning that those sites frequented most often for these reason will swallow the lions share of revenue in the future.

If GOOG grew revenue at such a torrid pace, could the converse also be true since they don't have market dominance and could lose revenue quickly too? The internet moves much faster as a business model than anything I've ever seen so it would appear possible that business could shift away from GOOG as quickly as it came to them under the right circumstances. How easy is it for a 80+ billion dollar company to again triple in value?

Jeff Matthews said...

"cdub" raises an excellent point regarding the apparent relative accleration of Microsoft's growth vs Google following the achievement of $1 billion in revenue.

However, it is based on faulty data--i.e. my own. It took Google 6 years to hit $1 billion, not 5, as I said. Consequently, it only took Google 2 years to get to $3 billion from $1 billion, rendering Microsoft's apparent acceleration vs Google null.

"gnanakan" raises good qualitative points about Google and the way past search engines have dropped by the wayside. This is precisely why Google's total focus on driving search--through new features such as images, maps, and satellite--very necessary to maintaining its position.

As for Microsoft undercutting the pricing to Google's partners, that is entirely possible.

jwoodywild said...

The simple fact is that changes in technology occur rapidly and are often very creative (meaning its something you didnt see coming). Another fact is that Search--either via text based, or voice activated, or via a vulcan mind meld, will be a part of any form of interactive communication where people need to quickly find something relevant in a universe of information that is vast.

My guess is that Google will be around in 5 years, growing at a modest clip, but all the really "leading edge" search advances will be coming from companies that dont even exist today--or are in their infancy.

But at that point GOOG wont care--they will just buy them. And then we will be down to an integration and execution story--and that is no different than any company in any industry covered by Wall St. today.

As for stock price--dont worry. If you bought in at any level below $200 a share, you will have made money if you sell it 5 years out...

mamis said...

Several comments:

1) I think your point about the time to $1B/$3B for MSFT vs. GOOG is misleading. The worldwide IT spend is so much larger now than it was in MSFT's early days that comparison between the two is meaningless.

2) I'm not sure what your purpose in saying "MSFT had a monopoly" is. Lots of companies had monopolies in the early days: Ashton-Tate with dBase, Lotus with 123, Borland in dev tools. They died, MSFT is alive. If you're claiming the competitive landscape is more aggressive now, then I, as a guy who worked at MSFT from the late 80s to mid 90s, would be happy to set you straight.

3) You did not mention how long it took for MSFT to get an $80B market cap. I realize you don't want to discuss GOOG's stock price and that's fine, but you should consider the impact the price has on recruiting. Every engineer hired in the first 20 years of MSFT became a millionaire if he stayed 4 1/2 years. That won't happen at GOOG.


To be clear: I admire GOOG. They are the most innovative firm in the business right now. But I wouldn't work there with the expectation of wealth, and I wouldn't touch the stock with your money, let alone mine.

Jeff Matthews said...

re "mamis":

1) My point in comparing Google's early growth to Microsoft's early growth is simple this: one is about as impressive as the other, in my view. If you think it is "meaningless" that Google reached $1 billion in sales in 6/15ths of the time it took Microsoft, okay.

2) You confuse the term "monopoly" with "market leader." Microsoft had a desktop operating system "monopoly." dBase had no monopoly--it had a market leading product with high market share. Same with WordPerfect and 1-2-3 and all the other products Microsoft squeezed out by undercutting prices and integrating them into an "Office Suite" bundle.

3) There you go talking about market cap. I never mentioned it and I don't see what bearing it has on the matter at hand.

(Also, I'm not sure if it's a good thing or a bad thing that all the Microsoft engineers became millionaires if they stayed 4 1/2 years--what is your point about that?)

mamis said...

In answer to your comments:

1) Yeah, I think we just gotta agree to disagree here. No disrespect.

2) I'm sorry, but you're just not correct about 1-2-3. I worked on Excel. Our market share was in the mid/high single digits when I started; 1-2-3 was in the mid 80s. This is roughly the same share split between MS-DOS and DR-DOS in the mid 1980s, or Win 3.x and OS/2 in the early 1990s. Why are MSFT's products monopolies and Lotus's are market leaders? Intel has a share in the mid 80s vs. AMD -- are they a monopoly or a market leader?

On Excel, we worked our way up to a 40-40 split (Quattro had the other 20) by 1994, at which point Office took off and beat the heck out of the other guys. Your assertion that Microsoft "squeezed out [1-2-3] by undercutting prices and integrating" Excel is simply not correct pre-1994. We got that share because we built a better product and we had better marketers.

3) Google is winning (partially) because it is recruiting the smartest and hardest working people in the business. MSFT is not. This is a virtuous cycle in GOOG's favor. I believe it will become a vicious cycle in a couple of years. If you don't think that's relevant, no problem; it's your blog.

3a) My only point about the MSFT engineers is that there was a 20-year virtuous cycle (OK, maybe more like 15 because they went public in '86) where MSFT had the pick of the litter because of the share price. That ended, and now MSFT's new hires are lower quality and less hard working. The same will happen with GOOG too -- but it will take a lot less than 15 years.

Jeff Matthews said...

"mamis":

Hey, I was there too when 1-2-3 came out, and I was there when Excel came out; same for dBase and QuattroPro and Access; same for all the other software products that Microsoft eventually either integrated into the OS or undercut.

It was fun days, because you could go to Comdex and meet the Microsoft product manager on Access and find out what the pricing plan was (I believe Access was priced at a $99 introductory offer when QuattroPro's list was $499--a pretty compelling discount) and then go out and short the daylights out of Borland.

It also worked the same way for Lotus, although where Microsoft really beat Lotus was in the transition from DOS to Windows. Lotus screwed it up and left the door open for Microsoft.

By the time Netscape came around, Microsoft stopped bothering with price-slashing and just gave away Internet Explorer.

So, back to what constitutes a "monopoly." A monopoly is what Microsoft developed with its operating system. Go to Best Buy and try to buy a PC that does not run on Windows. You can't. That's a monopoly, and it is highly unusual in the technology world because product cycles are so short.

Intel does not have a monopoly, although it has very high market share. Dell can buy a chip from Intel or it can buy a chip from AMD: it can not buy an OS for that chip from anyone but Microsoft.

There is no other company, not even DeBeers, that has an unregulated monopoly like Microsoft's--whether that is due to the brilliance of the engineers or the smarts of Bill Gates or the selling power of Steve Balmer.

As for the engineer issue, I was not disagreeing--I just didn't understand what you meant when you said all Microsoft engineers became millionaires the first twenty years. Your point that they got great engineers as a result of their stock is a good one, although not many outside observers would agree that Microsoft ever led the pack in innovation.

Most people--myself included--would argue that Microsoft used its operating system monopoly to take down the innovators.

mamis said...

1) Not sure what your point is about Access @ $99 vs. Quattro @ $499. They weren't competitors. Excel, 123, and Quattro all had the same price.

2) You're correct about the 123->Windows switch. Excel 4 got a 9.0 rating in Infoworld (the highest rating they had ever given any app, ss or not); 123 for Windows got a 6.7. Quattro got an 8.4, fwiw.

3) I followed INTC/AMD as a buysider for 2 years (2001-2003). Intel's P4 ASP was about $160. AMD's was about $80. Micron's variable cost breakeven for DRAM was about $4-5. While I agree that MSFT has a purer monopoly than INTC, any freshman Ec major could diagram INTC's monopoly profits.

(BTW, I mention Micron solely for comparison; no intellectual property, pure competitive fab biz.)

4) Good companies building good products have been impregnable to MSFT. Specifically, Intuit with Quicken (MSFT Money came out in 1991 and has never made a dent, because it stinks), and AOL vs. MSN (came out with Win 95). And now GOOG. Bad products and/or bad business models (NSCP, Lotus, Go) lose.

5) I just don't agree with you about the "innovation" thing, but I'm certain I can't convince you. I'll just tell you my thoughts, and if we disagree, no sweat.

All work in IT is derivative. Everybody steals everybody's ideas. A bunch of guys write Mosaic, give it away, and that's innovative. The same guys rewrite the same program, name it Netscape, give it away, and that's fine. MSFT rewrites Mosaic and gives it away...those bastards! They're not innovative! They're crushing the innovative spirit of blah blah blah. NSCP died because they HAD NO BUSINESS MODEL. "We'll be an infrastructure provider...er, I mean, a portal...er, I mean, we're going to turn Windows into a poorly written set of device drivers" (I loved that one). Their model was to sell a product that NCSA, MSFT, ORCL, SUNW and others were giving away. MSFT didn't crush an innovator; they crushed a company with no revenue model. BTW, my best friend from high school was one of the original 6 guys from Illinois who started NSCP (yeah, I kick myself daily for not joining him), and he's in agreement on this point. For whatever that's worth.

To bring this back to GOOG: I think GOOG is a great company, both technologically and business-wise. They're superior to MSFT in both respects. They do a great job of selling themselves and their culture. ("Don't be evil" -- brilliant, though untrue) You're right that their revenues are not vulnerable to attack by MSFT, as Lotus's, NSCP's, etc. were.

I just think people are too exuberant about them. Part of this is my contrarian nature; part is knowing some people inside GOOG; and part of it is my knowledge of how hard it is to maintain dominance in any segment of IT for a long time.

P.S. Trivia question on "innovation": can you name the first application ever written to use a toolbar? Hint: it starts with the letter E.

jwoodywild said...

mamis,

If GOOG continues to maintain 30%+ marketshare in paid search, and paid search is still in its infancy re: overall ad spending, then why shouldn't I be excited about GOOG's prospects over the next five years?

Are you saying that you think in the next few years a firm will come along and make GOOG's technology + marketing prowess obsolete?

Surely a fragmenting of the market to some extent is inevitable.

As for MSFT---monopoly or not, piss poor technology or not, 95% of the desktops run Windows....and pile of cash give you alot of freedom to do alot of things---including lose money via xBox, make crappy email ala hotmail, etc.

But as a shareholder, I like the freedom that a pile of cash gives you re: risk/reward.

I am not in tech, so these opinions make come off as incredibly naieve.

I am both a GOOG and MSFT shareholder....fwiw.

mamis said...

jwoodywild,

I don't know the paid search space well enough to know whether your assumptions are valid; I just haven't done enough work to argue the point. I don't own GOOG, but that's because I'm not smart enough to know what it's worth.

I think GOOG is a great company, and I don't see a path for MSFT to dethrone them in paid search. I think GOOG employees are, on average, better than MSFT ones right now. The reason GOOG can get such good employees is that they're making a lot of millionaires. But in a few years, they will not be making any more millionaires, and that's when recruiting gets hard.

When I joined MSFT, my strike (split-adjusted) was 32 cents. Market cap was about $3.5B. New GOOG employees are joining an $80B cap company. MSFT didn't hit $80B until the end of 1996, more than 10 years after going public. GOOG hit $80B after 10 months.

3-5 years from now, GOOG might be worth $1000 or $1. They may have 100% share or 1% share. I just don't know.

What I do know is, they won't be able to hire the best people anymore. That I guarantee you.

jwoodywild said...

Potentially true on recruiting, but I think the idea is that Paid Search, and its cash flow will become almost an annuity. A high margin, profitable business that requires an average amount of innovation to remain in a leadership position. And of course as the overall spend for Paid Search grows, so will their revenue. I dont think they will need brillant folks for this aspect of the biz.

I do think that they will continue to be able to attract top folks to work on new, innovative, skunk-work like projects. Top people are attracted by alot of things--challenge, freedom, and of course money. But I dont see GOOG having an issue offering any of these to a smaller group of innovators. After all, where is MSFT innovating? Where is YHOO innovating? eBay?

Lots of talented people in the world. You dont need 1,000 of them.

btw, what did your MSFT fortune amount to, if you dont mind me asking? Just to add perspective to the conversation....

mamis said...

jwoodywild,

1) I don't view EBAY and YHOO as tech companies; they're media companies, so innovation tends to be more of the creative, content production type. Different from tech innovation, IMO.

2) MSFT is actually innovating; you're just not seeing it yet. Specifically in the xbox and info appliance areas. As you implied earlier, a big pile of cash gives you a lot of freedom to try things that never see the light of day.

Of course, whatever innovations *do* see the light of day will be derided by Jeff and others as ripoffs...but that's off topic.

3) You're right that there are lots of talented people in the world, and nobody has a monopoly on them. But Jeff's original point (as I understood it) was that GOOG's technological innovation is driving traffic to the site. I agree with him. I'm just saying it won't last. How and when that hits the income statement, I don't know.

4) Money plays the biggest role in recruiting. Trust me. We used to call MSFT's price the "morale index". It affects everyone's state of mind, every day. GOOG employees are no different.

5) I made about $3M by the time I left in 1994. Of course it would've been nice to catch the next few doubles, like many friends did. But if you're a 27 year old kid who doesn't own a suit and who spent his teens playing D&D and collecting math club trophies, $3M ain't bad. I'm very lucky.

6) FWIW, I know lots of smart people who own GOOG. I'm well aware that a week from now it'll probably be $350 and my friends will be telling me what an idiot I am. I just can't get comfortable with the risk/reward. I'm a lot more comfortable with stuff like GLW.

But I'm sure you'll be a happy man at 5PM next Thursday, and I'll be left shaking my head.

jwoodywild said...

I appreciate your responses and the honest dialogue. Its fun to be able to debate with others. Most message boards about stocks are full of garbage.

I dont disagree with your points on stock price & morale. I have experienced that first hand. And I dont disagree that $$ is a factor, although not being a D&D geek I can say that its not as much of a motivation for me as I guess it is with those who are pure "techies". I am hesitant to admit I am an MBA (hold the tomatoes please...)

Regardless, I dont view GOOG as a short term investment. And therefore I am not really concerned about the Q2 earnings this week. In fact, given seasonality in the Internet sector and the momemtum traders who are pumping this thing, I would not be surprised to see a big (40%) dip in the stock even if they hit expectations. But as Jeff noted, they dont leak a single word---so who the hell knows what will happen?

And of course, if GOOG didnt exist 10 years ago, and they are Microsoft's thorn--then GOOG's thorn may just now be starting in some SF coffee shop somewhere....